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Signifikan: Jurnal Ilmu Ekonomi
Volume 9 (2), 2020: 241 - 256
P-ISSN: 2087-2046; E-ISSN: 2476-9223
Inflation-Unemployment Trade-Offs In ASEAN-10
Nurul Lisani1, Raja Masbar2, Vivi Silvia3*
*Corresponding author
Abstract
This study empirically explores the nature of inflation-unemployment dynamic causal relationships both in
the short and long-run in the ASEAN-10 over the 1989-2018 period. Based on the panel cointegration test,
the study documented a long-run equilibrium between inflation and unemployment. Using the Vector Error
Correction Model (VECM) analysis, the study found an insignificant inflation-unemployment relationship
in the short-run. However, in the long-run, inflation is found to affect the unemployment rate positively.
Our results from the Variance Decompositions (VDCs) analysis also supported these findings, where the
unemployment responded at the more significant percentage to shocks in inflation compared to the response
of inflation to shocks in unemployment. These findings only supported the relevance of the Phillips curve
theory in the long-run. Overall, these findings imply that although inflation targeting policy is not relevant
to the short-run, it becomes crucial and effective to reduce the unemployment rate in ASEAN-10 in the
long-run.
Keywords: inflation, unemployment, Phillips’ curve, trade-off relationship
Abstrak
Penelitian ini menguji dan menganalisis secara empiris sifat hubungan sebab akibat dinamis inflasi-
pengangguran baik dalam jangka pendek dan jangka panjang di negara ASEAN-10 selama periode
1989-2018. Berdasarkan uji kointegrasi panel, studi ini mendokumentasikan keberadaan keseimbangan
jangka panjang antara inflasi dan pengangguran. Menggunakan analisis panel Vector Error Correction
Model (VECM), penelitian ini menemukan hubungan inflasi-pengangguran yang tidak signifikan
dalam jangka pendek. Namun, dalam jangka panjang, inflasi ditemukan secara positif dan signifikan
mempengaruhi tingkat pengangguran. Bukti empiris ini juga didukung oleh temuan dari analisis Variance
Decompositions (VDCs) dimana pengangguran merespons dengan persentase yang lebih besar terhadap
guncangan inflasi dibandingkan dengan respons inflasi terhadap guncangan dalam pengangguran. Temuan
ini hanya mendukung relevansi teori kurva Phillips dalam jangka panjang. Secara keseluruhan, temuan
ini menyiratkan bahwa meskipun kebijakan penargetan inflasi tidak relevan untuk jangka pendek, tetapi
menjadi penting dan efektif untuk mengurangi tingkat pengangguran di negara ASEAN-10 dalam jangka
panjang.
Kata Kunci: inflasi, pengangguran, kurva Phillips, hubungan trade-off
JEL Classifications: E52, E58, J64
How to Cite:
Lisani, N., Masbar, R., & Silvia, V. (2020). Inflation-Unemployment Trade-Offs In Asean-10. Signifikan: Jurnal
Ilmu Ekonomi, 9(2), 241-256. doi: http://doi.org/10.15408/sjie.v9i2.16346.
Received: May 10, 2020; Revised: June 15, 2020; Accepted: July 05, 2020.
1, 2
Universitas Syiah Kuala, and Inspectorate Officer, Pidie, Aceh, Indonesia
Email: 1lisa2018@mhs.unsyiah.ac.id, 2rajamasbar@unsyiah.ac.id, 3vivisilvia@unsyiah.ac.id
DOI: htttp://dx.doi.org/10.15408/sjie.v9i2.16346Signifikan: Jurnal Ilmu Ekonomi
Volume 9 (2), 2020: 241 - 256
Introduction
Inflation and unemployment are twin-economic problems being faced by both
developed and developing countries. Inflation and unemployment shall cause a reduction
in the level of individual welfare as it deteriorates the real money value; thus, it must be
controlled to stabilize the economy. Bhattarai (2016) and Ruprah & Luengas (2011) found
that inflation and unemployment had reduced the well-being and the level of happiness
ranging from 1 to 8 points in Latin American countries and it doubled in the Organization
for Economic Co-operation and Development (OECD) countries. Inflation has also affected
the level of welfare and unemployment between age groups and the characteristics of the
labour market. Becchetti et al. (2010) documented that the social costs arouse due to inflation
and unemployment were higher in the middle age group and countries with weak labour law
protection. In other words, the level of welfare for the middle age group was lower compared
to different age groups due to the adverse effects of inflation and unemployment.
Inflation and unemployment have also been referred to as indicators to measure the
economic health of a country. Inflation has proven to be a significant determinant for economic
growth. High inflation reduces economic growth, causes fewer jobs available, and increases
the unemployment rate. These facts show the existence of a trade-off between inflation and
economic growth (Thanh, 2015). High inflation rates cause investment becoming riskier
because it is more difficult to anticipate future interest rates and nominal wage growth rates.
Inflation also increases some of the costs of the prices of other goods such as prices of foods,
raw materials, etc. Consequently, an increasing trend of labour forces was not supported by
expanding the availability of job opportunities would, in turn, contribute to an increase in
the unemployment rate (Hassouneh et al. 2018).
The problem of inflation and unemployment is also facing by developing countries,
such as in ASEAN. Apart from Singapore, which is categorized as a developed country, ten
other ASEAN countries are still classified as the developing countries, including Indonesia.
These countries have dissimilar economic performances, characterized by differences in
levels of income, inflation, unemployment, and other macroeconomic variables. Generally,
countries with medium and low incomes have higher inflation rates compared to high-income
countries. The high level of inflation is often not accompanied by the addition of aggregate
output. Thus, offering more job opportunities to reduce unemployment through increasing
in inflation would not be made possible. Finally, the high level of inflation causes an increase
in the unemployment rate.
The inflation rates in ASEAN from 1989 to 2018 have significantly fluctuated where
the highest inflation rate occurred in 1998, reaching 21.8% due to the 1997 East Asian
economic crisis (World Bank Report, 2019). The 1997 economic crisis has caused the value
of the currencies to plummet so that demand and investor confidence declined throughout
the world. The global financial crisis has re-occurred in 2008, cantered in the United States
and has caused inflation to increase to 13.5% (World Bank Report, 2019). This crisis has
caused a simultaneous decline in all sectors of economic activity such as employment and
investment, and company profits. The adverse effect of the global crisis continued until 2009
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Inflation-Unemployment Trade-Offs In ASEAN-10
and caused the deflation rate reaching 2.3%. Instability of the rate of inflation in ASEAN
in few last decades has been a significant factor inhibiting economic growth and economic
welfare (World Bank Report, 2019).
Although inflation in ASEAN countries has been very volatile a few decades ago, the
unemployment rate in ASEAN has been reasonably stable, ranging from 2.7% to 3.5%. This
fact shows that changes in the inflation rates were not entirely followed by changes in the
rates of unemployment. This fact has made the topic of the relationship between inflation
and unemployment becoming one of the most critical issues discussed in economic theory.
For example, Phillips’ (1958) curve shows a negative relationship between the unemployment
rate and the inflation rate. This implies that as inflation rises, the unemployment falls,
and vice versa. The trade-off between inflation and unemployment, from the perspective
of economic policy-makers, shows that efforts to reduce the unemployment rate in the
short term could be made by increasing inflation through expansionary economic policies
(Bhattarai, 2016). However, an increase in prices due to workers demanding higher wages
causes the unemployment rate to increase. This is in line with the study by Sachsida et al.
(2011) when a government intends to reduce unemployment using monetary policy; people
expect inflation to increase in the long-run. The inflation-unemployment trade-off might
only occur in the short term, but a high inflation rate will not be followed by a reduction in
the unemployment rate in the long-run.
According to Palley (2012), the Phillips curve only relevant to explain the relationship
between inflation and unemployment in the short run. Besides, previous studies have shown
that Phillips curve theory is not entirely consistent across countries. For example, Bhattarai
(2016) recorded a Phillips curve relevancy in explaining inflation-unemployment relationships
for 28 of the 37 OECD countries, especially countries in the European Union, but it was
not relevant in countries such as Austria, Brazil, Germany, Ireland, Israel, and Norway. Moise
(2015) explored the suitability of the Phillips curve in Romania over the 1996-2012 periods.
He found that the Phillips curve was only able to explain the relationship between inflation
and unemployment among the workforce aged 15-19 years old in the 2008-2012 periods,
but it was irrelevant for the entire study period.
According to Grammy (2019), the existence of prolonged inflation-unemployment
trade-off might create a problem for policy-makers. If there a continuous implementation
of trade-off policy, a lower unemployment rate will accelerate the already rapid inflation
rate and efforts to curb inflation tend to increase the unemployment rate that remains
high. This is evidence in the studies by Karanassou & Sala (2010), Ruprah & Luengas
(2011), Sachsida et al. (2011), Dritsaki & Dritsaki (2012), Tesfaselassie & Wolters (2018),
Donayre & Panovska (2018), and Hindrayanto et al. (2019). They recorded an adverse
effect of inflation on unemployment. Likewise, this happens for a country that implements
inflation targeting and economic activity targeting policies; its unemployment rate tends
to reduce.
Phillips curve theory is unable to explain the nature of the inflation-unemployment
relationship entirely. Chletsos et al. (2016), for example, found that the Phillips curve
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model is suitable for the United States, but it is irrelevant in Canada. Safdari (2016)
also found mixed findings of the relationship between inflation and unemployment. The
relationship between the two is usually negative on a specific time scale, but positive on
another time scale. Haug & King (2014) also found a positive relationship between inflation
and unemployment in the long-run. Likewise, Louis & Balli (2013) showed that inflation
shocks, viewed from the differential interest rates, had no impact on unemployment in the
short-term.
Many previous studies have explored the relationship between inflation and
unemployment relationship for the case of developed countries. However, those studies
only focused their analyses only on a specific country (Karanassou & Sala, 2010; Dritsaki
& Dritsaki, 2012; Haug & King, 2014; Putnam & Azzarello, 2015; and Grammy, 2019).
Overall, the findings of their studies implied that in anticipating the negative impact inflation,
labour protection, and improvement of the investment ecosystem must be done to increase
production.
Likewise, with the studies of the inflation-unemployment relationship in Indonesia,
in general, they focused on a particular city and province and documented mixed empirical
evidence. For example, Siregar (2015) examined the effect of inflation on unemployment
in Medan City over the period from 2000 to 2014 and found a positive impact of inflation
on the unemployment rate. A similar finding was also found by Prayuda et al. (2016) in the
province of Bali over the 1994-2013 period. Although, inflation was seen to have a positive
effect on educated unemployment in Central Java in the 2009-2013 period (Putri, 2015), but
its effect was insignificant during the 2017-2019 period (Al-Umar, 2020).
Furthermore, an insignificant effect of inflation on unemployment was also found by
Podi et al. (2020) in Jambi City during the period 2000-2017, in Indonesia by Setyowati
(2017) and Astuti et al. (2020), respectively, during the period 1987-2015 and 1986-2017,
in the provinces of West, Central, South, East and North Kalimantan by Rochaida & Fitriadi
(2020) during 2014-2018, and by Elviani et al. (2020) in East Kalimantan over the period
2008-2017. Conversely, in Samarinda City, inflation was found to have a negative effect on
unemployment during 2005-2014 (Susanto et al. 2018) and the 2001-2016 periods (Faisal
et al. 2019).
The mixed empirical evidence of the inflation-unemployment relationship in other
countries and also in cities and provinces in Indonesia has motivated our study to be carried
out at the ASEAN level so that it can test the overall causality of inflation-unemployment in
ASEAN. In contrast to previous studies which generally only explored the long-term effects
of inflation on unemployment in Indonesia by using regression analysis, this study examines
the existence of a long-run equilibrium between inflation and unemployment in ASEAN by
using panel cointegration analysis.
Furthermore, the purpose of this study is not only to explore the effect of inflation
on unemployment in the short term, but it also to examine it in the long-run perspective
using the Vector Error Correction Model (VECM). To support our findings related to the
interaction between inflation and unemployment, and the test of variance decomposition
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to assess how the investigated variables will respond to the shock that occurs in another
variable. This is the main novelty of our study. The results of this study are expected to be
a reference for the government in setting economic policies to manage inflation to reduce
the unemployment rate. The rest of this research is organized into several sections. Section 2
discusses the research method, followed by a discussion of the results and their implications
in Section 3. Finally, Section 4 concludes the study.
Methods
This study explore inflation-unemployment trade-offs in the ASEAN-10. These
countries include Indonesia, Malaysia, Singapore, Thailand, the Philippines, Brunei
Darussalam, Vietnam, Laos, Myanmar, and Cambodia. This study utilizes an annual panel
data of consumer price index and the unemployment rate of ten ASEAN countries from the
period 1989 to 2018 for the analysis. These data are sourced from the World Bank report.
Inflation is measured by the changes in the consumer price index, while unemployment is
measured in the percentage of unemployed labour forces.
To test the existence of a long-run equilibrium between inflation and unemployment
in ASEAN, this study uses a panel cointegration test. Meanwhile, to examine the short- and
long-term relationships between inflation and unemployment and their dynamic causalities,
this study uses a panel model Vector Error Correction Model (VECM). Finally, to test the
extent to which a shock in a variable is responded to by another variable, this study uses
Variance Decompositions (VDCs) approach. However, before estimating our proposed
models, the panel stationarity and determination of the optimal lag-length to be included in
the model will be determined in advance. Specifically, six stages of estimation are involved in
the study.
In the first stage, to test the stationarity of the investigated variables, this study
uses the Augmented Dickey-Fuller (ADF), Levin Lin Chu (LLC), and Phillip Peron (PP)
techniques. If the probability value of the test is less than 5%, then the null hypothesis
of unit root is rejected, implying the non-stationarity of the variables, and vice versa. In
the second stage, Johansen’s cointegration test is estimated if the variables have a unit
root at the level, but they become stationary on the same order of integration after taking
differenced.
In the third stage, to the determine the optimal lag-length to be included in the
estimated model of the panel Vector Auto-Regressive (VAR) model, the study uses criteria of
Final Prediction Error (FPE), Akaike Information Criteria (AIC), and Schwartz Information
Criterion (SC).
In the next stage, the VECM is estimated to explore the short- and long-run relationship
between inflation and unemployment and their dynamic causalities. This model can also
measure the speed of adjustment of the short-run imbalance moving towards the long-
run equilibrium. This study adopts the panel VECM technique proposed by the studies of
Hassouneh et al. (2018) and Liang & Schienle (2019). In general form, the equation of panel
VECM can be written as follows:
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(1)
where ∆ is the first differentiation of the variable; Yt is a vector of inflation and unemployment
variables; µ is the VECM model parameter; αβ’Yt-1 is an error correction term; α is an
adjustment term that measures the speed of variable correction from short-term deviation
to long-term equilibrium. β’ is a vector of cointegration; p is the order in integration; θ is
the short-term dynamic adjustment for variable changes in the system, and εt is the error
term.
Meanwhile, to test the causality relationship between inflation and unemployment,
the panel dynamic causality model of Mandal & Madheswaran (2010) and Amountzias,
Dagdeviren, and Patokos (2017) is adopted. The estimated model can be written in the
following equations:
(2)
(3)
Where, αβ’Y1 and αβ’Y2, t-1 are the error correction terms. The existence of causal
relationships between inflation and unemployment can be identified through the statistical
significance of estimated variable coefficients. To measure the short-run causality, the null
hypothesis of θi = 0 is tested against its alternative hypothesis, θi # 0, while to identify the
long-term causality; it can be viewed from the statistical significance of error correction term.
The null-hypothesis of α = 0 is tested against its alternative hypothesis of α # 0 (Mandal &
Madheswaran, 2010).
Finally, Variance Decompositions (VDCs) is used to evaluate dynamic relationships
between inflation and unemployment. Possible inflation change is contemporary associated
with changes in unemployment. This implies that shocks in unemployment are likely to
work throughout contemporary connections to shocks in inflation. The VDCs can identify
changes in unemployment respond to the relative strength of shocks in inflation, and vice
versa (Kassim & Majid, 2010; and Majid, 2018). It also enables us to identify how long the
shocks in inflation could affect the unemployment rate before it returned back to normal
position. Finally, VDCs also provides us how big is the effect of shocks in one variable causing
other variables to change before it returned back to normal condition (Majid, 2018; and
Mohd Yusof et al., 2009).
Results and Discussion
Before the study reports the short- and long-run relationships and their dynamic causal
interaction between inflation and unemployment in ASEAN, the unit root test is firstly
conducted.
Unit root test
To ensure the stationarity of data, the unit root tests are conducted using the Augmented
Dickey-Fuller (ADF), Levin Lin Chu (LLC), and Phillip Peron (PP) approaches. This is
performed to find out whether the variance of data is constant over time and its co-variance
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between time series data only depends on the lagging time periods. Table 1 report the findings
of the unit root tests.
As illustrated in Table 1, both variables of inflation and unemployment rate were
found to contain unit root at the level, implying the non-stationarity of data. This is
indicated by the insignificant p-value of greater than 5% or stationary tests, ADF, LLC, and
PP. Thus, to arrive at the data stationarity, the first differenced is taken. The study found
that, at the first difference, the data becomes stationary, as indicated by the significant
p-value of 1%. These findings fulfil the necessary condition for the cointegration test to be
conducted as the data having non-stationary at the level, but they become stationary at the
order of integration, I(1).
Table 1. Panel Unit Root Test (P-value)
Variable LLC ADF PP
At Level
Inflation 0.2360 0.2467 0.2111
Unemployment 0.4203 0.9139 0.9265
At First Difference
Inflation 0.000*** 0.000*** 0.000***
Unemployment 0.000*** 0.000*** 0.000***
Note: *** indicates significance at the 1% level.
Since the cointegration test takes into consideration the effect of lag values in the
model, thus the study firstly determines the optimal lag-length to be included in the model.
This would eliminate the autocorrelation problem in the VAR panel system. In this study, the
optimal lag-length is determined using the Final Prediction Error (FPE), Akaike Information
Criterion (AIC), and Schwartz Information Criterion (SIC). All these criteria confirmed
that the optimal lag-length of equal to one should be included in the estimation as these lag
produced the smallest prediction errors.
Long-run equilibrium
To identify the existence of a long-run equilibrium between inflation and
unemployment, the Johansen cointegration is performed. Table 2 reports the findings of
maximum Eigenvalue and trace statistics of the cointegration test. As observed from Table 2,
two cointegrating vectors were found in Model 1 (i.e., inflation-unemployment relationship),
as indicated by significances of both maximum Eigenvalue and trace statistic value at the 1%
level. Similarly, two cointegrating vectors were also found in Model 2 (i.e., unemployment-
inflation relationship), as shown by significances of both maximum Eigenvalue and trace
statistic value at the 1% level. This finding is supported by previous studies, such as Ho
and Iyke (2019) in the Euro zone, Stamatiou and Dritsaki (2019) in Poland, Abu (2019) in
Nigeria, and Gomis-Porqueras et al. (2020) in 76 countries.
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Table 2. Johansen Panel Cointegration Test (Lag = 1)
Hypothesis Eigenvalue Trace Statistic 5% Critical Value P-value
Model 1: Inflation, Unemployment
None 0.5730*** 485.7290*** 15.4947 0.0001
At most 1 0.5437*** 233.0180*** 3.8415 0.0000
Model 2: Unemployment, Inflation
None 0.5729*** 252.7110*** 14.2646 0.0001
At most 1 0.5436*** 233.0180*** 3.8415 0.0000
Note: *** indicates significance at the 1% level.
The presence of cointegration shows the tendency of variables in the models to move
together in the long-run (Majid, 2007; and Majid & Kassim, 2015). Thus, our findings
further imply that the rates of inflation and unemployment in the ASEAN tend to move
together in the long-run. To predict one variable, it might be used other variable. In other
words, to predict the long-run movement in the unemployment rate, the policy-maker could
be used inflation rate as the referral predictor. Having identified stationarity of the variable
at the order of integration, I(1) and the cointegration between inflation and unemployment,
thus the study could properly adopt and estimate VECM to identify short- and long-run and
dynamic causalities between the variables.
Short-run, long-run, and dynamic causal relationships between inflation and
unemployment
Table 3 illustrates the findings of the short- and long-run relationship between inflation
and unemployment in ASEAN-10. Table 3 shows that, in the short-run, inflation has an
insignificant effect on the unemployment rate. Similarly, unemployment is found to have
an insignificant impact on inflation. These findings imply that any changes in inflation have
caused no changes in unemployment, vice versa. In other words, the study documented
a non-causal dynamic relationship between inflation and unemployment. This could be
partially due to the relatively lower rate of inflation in the ASEAN-10 over the study period.
On average, the inflation rates in the region have been last than two-digit. In addition, there
might be a time lag of the effect of inflation on unemployment, which is only significant in
the long-run.
The absence of a causal relationship between inflation and unemployment in
ASEAN-10 shows the interdependence of the level of unemployment from inflation rate.
This evidence demonstrated an inability of Phillips curve theory explain the nature of the
inflation-unemployment relationship, finding similar to Chletsos et al. (2016). They found
that the Phillips curve model is irrelevant in Canada. Similarly, Louis & Balli (2013) showed
that inflation had no impact on unemployment in the short-term. However, the changes in
unemployment rates in the ASEAN-10 could be contributed by several factors, such as high
taxes, instability of monetary policy, low investment, and sustainable corruption (Dritsaki
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Inflation-Unemployment Trade-Offs In ASEAN-10
& Dritsaki, 2012); thus the goals of reducing unemployment rate through expansionary
policies have been ineffective.
In addition, the findings of the insignificant trade-off between inflation and
unemployment for the case of ASEAN-10 in the short-run are supported by the previous
study by Bhattarai (2016), who documented insignificant inflation-unemployment trade-
off in 32 OECD countries. Our findings are also in harmony with the studies by Podi et al.
(2020) for the case of Jambi City, Indonesia, Setyowati (2017) and Astuti et al. (2020) for
the case of the provinces of West, Central, South, East and North Kalimantan, Indonesia,
Rochaida & Fitriadi (2020) and Elviani et al. (2020) for the case of East Kalimantan
region.
Table 3 shows that the last-year disequilibrium in inflation in the short-run, it
would be corrected with the speed of adjustment of -0.5065 to move towards the long-run
equilibrium, as indicated by negative significance of error correction term (ECT). In other
words, for any short-run disequilibrium, it takes half-year period for moving towards the
long-run equilibrium. The negative ECT value shows the convergent trend of inflation and
unemployment movement in the long-run., as indicated by the negative significance of the
error correction term (ECT). In other words, for any short-run disequilibrium, it takes half-
year period for moving towards the long-run equilibrium. The negative ECT value shows the
converging trend of inflation and unemployment movement in the long-run. This further
implies the existence of a long-run equilibrium between inflation and unemployment in the
ASEAN-10.
Table 3. Short- and Long-run Inflation-Unemployment Relationship (Lag =1)
Variable D D ECTt-1
Short- and long-run relationship
D - -0.5969 -0.5065***
(-0.5787) (-9.0954)
D -0.0012 - 0.0006
(-0.3892) (0.4566)
Long-run relationship
D - 0.4260 n.r
(0.5756)
D 2.3473*** - n.r
(9.1822)
Note: *** indicates significance at the 1% level. n.r is not relevant.
On the other hand, the study also finds inexistence of long-rung equilibrium between
unemployment and inflation, as indicated by the insignificance of error correction term
(ECT). This finding is in line with the studies by Sayeed et al. (2019) in the US, Abu (2019)
in Nigeria. This finding shows the importance of inflation to determine the movement of
the unemployment rate in the long-run. Thus, to manage the level of unemployment, the
inflation targeting policy is found to be effective. This further shows the importance of for
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the ASEAN-20 government to control and keep inflation within tolerable rate as one of
the strategic economic policies to reduce the unemployment rate in the ASEAN. Thus,
macroeconomic coordination among ASEAN governments should be strengthened.
As for the long-run relationship, the study found a significant positive effect of inflation
on unemployment rate in the ASEAN-10 with an estimated value of 2.3473 at the level
of 1%. This, specifically, shows that an increase in inflation rate by 1% has also caused a
rise in the unemployment rate of 2.3473%, ceteris paribus. On the other hand, changes in
unemployment are documented to have an insignificant effect on inflation throughout the
study period. These findings further show a significant unidirectional impact running from
inflation to unemployment in the ASEAN-10, similar to the findings by Abu (2019) for
the case of Nigeria and Sahnoun and Abdennadher (2019) for the case on North African
countries.
Although the changes in inflation caused no effect on changes in unemployment in the
short-run, but its effect turned to be significant in the long-run. This finding implies that,
from the economic policy perspective, policy-makers should not ignore the role of inflation
in creating public welfare as it has significant contribution to create job opportunities and
thus reduce unemployment in the log-run (Drobyshevskiy et al., 2019). An increase in prices
as the primary phenomenon of inflation causes a reduction in public purchasing power.
Consequently, it causes a decline in the sales of goods and services of the firms. This, in
turns, leads to lower corporate profits and causes the inability of firms to offer more jobs for
the public (McLeay & Tenreyro, 2020). An increasing trend in labour force in ASEAN-10,
which is not supported the growing job opportunities have caused more unemployment in
the region.
This finding is similar to the discovery of the study by Haug & King (2014) who
documented a significant positive effect of inflation on unemployment. Siregar (2015) also
found a significant positive impact of inflation on unemployment in Medan City, Indonesia.
A similar positive significant inflation-unemployment relationship is also recorded in the
studies by Putri (2015) in Central Java and by Prayuda et al. (2016) in the province of Bali,
Indonesia.
This positive causal relationship occurs because of an expansive policy undertaken
to boost the economy. For example, by increasing the money supply to raise people’s
purchasing power by increasing the prices of goods and services is often not accompanied
by increasing aggregate output. Thus, the initial goal of rising inflation to create more job
opportunities and reduce unemployment rates could be materialized. Finally, the high
level of inflation will only add to the unemployment rate. This positive causality between
inflation and unemployment in the long-run also happened, inter alia, because of a more
volatile global economic condition in the last few decades (Haug & King, 2014). Overall,
our findings show the importance of macroeconomic harmonization to stabilize prices to
reduce the unemployment rate within the ASEAN-10.
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Inflation-Unemployment Trade-Offs In ASEAN-10
Findings of Variance Decompositions
To provide further evidence of the inflation-unemployment relationship, the analysis
of Variance Decompositions (VDCs) is estimated to explain the relative importance of each
variable in a VAR model. Thus, the VDCs measure the percentage change in a variable caused
by a shock in another variable. The findings of the VDCs are reported in Table 4.
Table 4. Findings of Variance Decompositions
Period Inflation Unemployment
Inflation Unemployment Unemployment Inflation
1 99.9819 0.0180 100.0000 0.0000
2 99.9870 0.0129 99.8276 0.1724
3 99.9845 0.0155 99.7617 0.2383
4 99.9739 0.0261 99.7039 0.2961
5 99.9613 0.0387 99.6534 0.3466
6 99.9497 0.0503 99.6064 0.3936
7 99.9397 0.0603 99.5616 0.4384
8 99.9314 0.0685 99.5179 0.4821
9 99.9246 0.0754 99.4749 0.52514
10 99.9189 0.0811 99.4322 0.5678
As observed from Table 4, it revealed that changes in themselves mainly contributed
to the changes in inflation and unemployment in the ASEAN-10 over the period from 1989
to 2018. Changes in inflation only explained by 1.80% changes in unemployment for the
period 1, 1.29% (period 2), 1.55% (period 3), 2.61% (period 4), 3.87% (period 5), 5.03%
(period 6), 6.03% (period 7), 6.85% (period 8), 7.54% (period 9), and 8.11% (period 10).
Overall, the shock in unemployment rate contributed to changes in the inflation rate of
less than 10%. This finding in harmony with previous studies by Wulandari et al. (2019)
and Hongo et al. (2019), who found the lack of interdependent of inflation to the shock
in unemployment in the Indonesian and Kenyan economies, respectively. These findings
supported our earlier findings of the insignificant effect of unemployment on inflation and
non-causal dynamic relationship between the two.
On the other hand, changes in unemployment are explained by changes in inflation by
zero % changes in inflation for the period 1, 17.24% (period 2), 23.83% (period 3), 29.61%
(period 4), 34.66% (period 5), 39.36% (period 6), 43.84% (period 7), 48.21% (period
8), 52.51% (period 9), and 56.78% (period 10). These findings showed that the changes
in inflation have contributed to larger changes in unemployment, similar to the findings
by Horvath & Zhong (2019) for the case of emerging economies and Ambrocio (2020)
for the case of European countries. Overall, the changes in unemployment rate have been
contributed by more than 55% shocks in inflation over the ten periods of the study. These
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Volume 9 (2), 2020: 241 - 256
findings supported our earlier findings of significant effect of inflation on unemployment and
a unidirectional causal dynamic relationship running from inflation to unemployment. From
policy markers perspective, these findings confirmed the important role of inflation targeting
policy to reduce unemployment within the ASEAN economic region.
Overall, our findings provide evidence that Phillips curve theory is unable to explain
the nature of the inflation-unemployment relationship in the short-run entirely. However, in
the long-run, the significant positive relationship is documented to support the Phillips curve
trade-off in the ASEAN-10. These findings imply that although inflation is not a relevant
economic policy to be focused on reducing unemployment in the short-run, but the inflation
targeting policy turned becoming essential and useful measures to reduce unemployment in
the ASEAN-10. As our study using panel data, thus it is utmost necessary for the countries
to harmonize their macroeconomic policies to stabilize price as it has a significant influence
on the reduction of unemployment rate in the ASEAN region.
Conclusion
This study empirically investigated the short-and long-run relationships between inflation
and unemployment rate in the ASEAN-10 over the period from 1989 to 2018. It also attempted
to assess the dynamic causal relationship between the variables. By using a panel cointegration
test, the study documented a long-run equilibrium between inflation and unemployment.
Besides, based on the Vector Error Correction Model (VECM) analysis, the study found
insignificant inflation-unemployment relationship in the short-run, but the relationship turned
to become positively and significantly related. Finally, using the Variance Decompositions
(VDCs) analysis, the changes in the unemployment rate were primarily explained by the shocks
in inflation compared to the inflation response to the shocks in the level of unemployment.
Our findings only supported the Phillips curve theory’s relevance in the long-run, but
did not in the short-run. Overall, these findings imply that although inflation targeting policy
is not relevant for the short-run, it becomes crucial and effective to reduce the unemployment
rate in the ASEAN economies in the long-run. This further shows the Phillips curve theory’s
ability to explain the nature of the inflation-unemployment relationship in the short-run
entirely. However, in the long-run, the significant positive relationship is documented to
support the Phillips curve trade-off in the ASEAN-10. Thus, to reduce unemployment in the
ASEAN-10, macroeconomic policy harmonization, specifically, inflation-targeting policy is
of utmost importance.
Future studies on inflation-unemployment trade-off are suggested to utilize more data
frequency and cover a more extended data period to offer more conclusive empirical evidence.
Incorporating more macroeconomic determinants of unemployment could provide more
strategic economic policy to reduce unemployment in the ASEAN economies.
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